Hungary surprised markets this week with comments seeming to favor a weaker currency. Remarks to this effect by a government official gave a sneak preview to what monetary and exchange-rate stance Hungary may pursue under him as the central bank governor, said traders in the Hungarian forint and economists following Hungary.

Economy Minister Gyorgy Matolcsy, who is widely tipped in the local press as the leading candidate to head the central bank from March, said Thursday that keeping the forint strong between 2002 and 2010, when the Socialists–the biggest opposition grouping to the current governing Fidesz party–were in power, was a mistake.

“Under the orthodox economic thinking, it looked rational to draw loans in low-interest euros and Swiss francs to amass most of the state debt in a foreign currency, … to keep the forint strong because that would rein in inflation and let the budget deficit widen above 3% of gross domestic product. These decisions proved catastrophic after the crisis,” Mr. Matolcsy said in a book review he wrote for political weekly Heti Valasz.

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The comments sent the forint tumbling. The currency weakened at “a panicky speed,” a trader said, about 3% by Friday afternoon from Thursday morning, nearing the psychological level of 300 forints to the euro. It considerably underperformed its regional peers, the Polish zloty and the Czech koruna.

“These comments are a shock to me … I would have thought Matolcsy would have understood” that a weak currency has a negative impact on Hungarian consumption, offsetting the positive effect on exports, because of the high level of foreign-currency debt held by Hungarian households and companies, said Nomura economist Peter Attard Montalto.

Even if it’s not Mr. Matolcsy who will be at the helm of the central bank next, the remarks still show what lies ahead, he added.

“Either way, the person there will be doing the government’s and Matolcsy’s bidding in a ‘strategic partnership’ to boost growth,” Mr. Attard Montalto added. The Nomura economist was referring to Mr. Matolcsy’s comments in December that “strategic cooperation” is necessary between the central bank and the government.

Hungary has no exchange rate target, Gyula Pleschinger, state secretary at the economy ministry, told The Wall Street Journal Friday. Mr. Pleschinger also said that a weaker forint cuts both ways.

A weak forint is beneficial to exporters while, at the same time, is negative for the numerous Hungarian households that hold mortgages tied to a foreign currency, mostly the Swiss franc, Mr. Pleschinger said. A weaker forint is also negative for the state budget since it increases the government’s interest payments on state debt held in foreign currencies, he added.

Mr. Pleschinger’s comments supported the forint somewhat but failed to quell the concerns.

Markets became deeply worried as they took the endorsement of a weaker forint into account with earlier comments from Mr. Matolcsy that the central bank could inject cash into the economy in the fashion of the U.S. Federal Reserve and the European Central Bank. They now fear Hungary will loosen its monetary policy even further and would tolerate a weaker currency. That could drive inflation higher and would fail to help achieve sustainable economic growth, they said.

“The risk of a new unconventional central bank policy is probably the most significant idiosyncratic risk in 2013 for Hungarian assets,” said Morgan Stanley economist Pasquale Diana in a research note about Hungary, titled “Hungary: Another Year of Living Dangerously?”

Embarking on a monetary policy that markets and investors find risky may backlash.

“The irony of this is that the appointment of a [government] loyalist [to head the central bank] could actually limit the room for rate cuts by leading to a rise in Hungary’s risk premia and a selloff in local assets, thus forcing a tighter policy stance,” said Capital Economics analysts William Jackson and Neil Shearing.

Comments (1 of 1)

Please make a minimal effort to learn how to use the switch between the Hungarian keyboard, and the English keyboard.

We write: György not "Gyorgy", Heti Válasz not "Valasz", Fehér not "Feher" (your own name for God's sake!).

It is really a very minimal expectation to show respect for the culture you write about. When people write about the French, German, Czech, Polish etc. culture they do respect the orthography of those nations. We Hungarians demand the same standards of professionalism!

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